Question

A company is considering purchase of a piece of equipment that costs £23,000. Projected net annual cash flows over the project's life are: Year Net Cash Flows 4,000 7,000 15,000 10,000 (a) Calculate the payback period for the project. (3 marks) (b) Calculate the net present value for the project, assuming a cost of capital of 11%. (4 marks) (c) Determine the internal rate of return for the project. (3 marks)

Answer 1

a) Computation of Payback period :- Cash Cumulative Year Flows Cashflows Pounds Pounds (23,000) (23,000) 4,000 (19,000) 7,000 (12,000) 15,000 3,000 10,000 13,000 Payback period is = 2 years +(12000/15000) Payback period is = 2.80 years b) Determination of Net Present Value :- Cash Year Flows PVF @11% Pounds (23,000) 1.0000 4,000 0.9009 7,000 0.8116 15,000 0.7312 10,000 0.6587 Net Present Value Present Value Pounds (23,000) 3,604 5,681 10,968 6,587 3,840 Net Present Value is $ 3,840/. Internal rate of return is the rate at which the Net Present value of Cashflows is ZERO. Using trial and error method we can find the Internal rate of return as below:- PVF Determination of Internal rate of return; Cash Present Year Flows Value @17.439% Pounds Pounds (23,000) 1.0000 (23,000) 4,000 0.8515 3,406 7,000 0.7251 5,075 15,000 0.6174 9,261 10,000 0.5257 5,257 0.5 Net Present Value (0) Internal rate of return is = 17.439% Approx.